Question

Explain how the prices of goods and services used in the CPI differ from the prices reflected by GDP deflator.

Answer 1

The first difference is that the GDP deflator measures the prices of all goods and services produced, whereas the CPI measures the prices of only the goods and services bought by consumers. An increase in the price of goods bought by firms or the government will reflect up in the GDP deflator not in the CPI.

The second difference is how the two measures aggregate the many prices in the economy. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns varying weights. The CPI is calculated using a fixed basket of goods, whereas the GDP deflator allows the basket of goods to change over time as the composition of GDP changes.